Arbitrage fund inflows rise 33% in May as investors chase low risk, tax efficient options

Arbitrage funds seek to exploit the price differential between the spot and futures markets. Fund managers simultaneously buy stocks in the cash market and sell them in the futures market when futures prices are higher, locking in the spread.

Arbitrage mutual funds have recorded a sharp 33% jump in net inflows during May, adding Rs 15,702 crore, as per data from mutual fund association AMFI, showing sustained investor interest in times of market volatility, and a growing preference for stable, low-risk option.

“Arbitrage is gaining interest because, during volatile periods, markets can potentially offer good spread opportunities,” said Karthik Kumar, Fund Manager at Axis Mutual Fund. The low-risk nature of the product makes it appealing, he added, pointing out that regulatory changes have expanded the universe of tradable securities over the last few months.

By AUM, the largest arbitrage fund is Kotak Equity Arbitrage Fund (Rs 67,362 crore) followed by SBI Arbitrage Opportunities Fund (Rs 33,759.32 crore) and ICICI Pru Equity Arbitrage Fund ( Rs 28,444 crore).

Returns Strong, Even After Tax

Arbitrage funds are especially attractive due to their tax efficiency, and they are treated as equity funds, offering favourable taxation than many debt-oriented funds.

“Even last month, arbitrage delivered annualized returns in the 6.65–6.7% range. When adjusted for tax, that’s better than comparable short-term fixed income products, particularly now that debt instruments are taxed at marginal rates,” said Abhishek Tiwari, Executive Director & Chief Business Officer at PGIM India Mutual Fund.

Tiwari highlighted the category’s decent performance as another advantage. “Even on a three-month basis, returns are in the 6.5–6.75% range depending on the fund. That predictability, paired with tax efficiency, is the main attraction.”

On a one-year basis, the best performing arbitrage fund is UTI Arbitrage Fund with returns of around 7.11 percent, followed by ICICI Pru and Kotak with returns of around 7.05 percent. Benchmark returns for the period are currently around 7.25 percent.

Opportunities Amid Liquidity Shift and Volatility

Fund managers also said more opportunities have emerged with the shift in liquidity. “The liquidity in the system has moved into surplus. Arbitrage funds typically deliver returns in line with short-term money market rates. Given the softening trend, return expectations should be calibrated accordingly,” said Prashant Joshi, Head of Products at Motilal Oswal AMC.

Arbitrage funds are also benefitting from a heightened market volatility, which tends to widen the spread between the cash and futures markets, said Himanshu Srivastava, Associate Director at Morningstar. “Volatility in the markets has been high, and the spread between the cash and futures market is attractive. Arbitrage becomes a smart alternative to ultra-short or money market funds, especially with the tax edge.”

Experts also said that the demand for arbitrae funds is broad-based. “If you look back not just at last month but over the past year, arbitrage has attracted a lot of interest,” said Abhishek Tiwari of PGIM India MF, adding that investors have been more cautious in deploying capital into equities. “Arbitrage has emerged as a preferred parking option due to its stability and structure,” he added.

Even in periods where spreads dip, managers said that these funds have not turned unattractive. “We’re still seeing market-wide rollovers well above the three-month average,” Tiwari added. “That shows demand remains strong, and arbitrage continues to appeal to both equity- and debt-focused investors.”

How Arbitrage Funds Work

Arbitrage funds seek to exploit the price differential between the spot and futures markets. Fund managers simultaneously buy stocks in the cash market and sell them in the futures market when futures prices are higher, locking in the spread.

Prashant Joshi, Head of Products at Motilal Oswal AMC cited an example. “If a fund buys a stock at Rs 1,000 in the spot market and sells it at Rs 1,100 in the futures market, it locks in a Rs 100 gain, regardless of how the price moves thereafter. The profit comes from the convergence of spot and futures prices.”

These funds typically hold about 65% in equities and derivatives (to qualify as equity funds for tax purposes), with the remainder in fixed income instruments. The strategy is designed to deliver steady, low-risk returns without taking directional market exposure.

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